Remaining Optimistic Amid Volatility
The post-pandemic economy has created a variety of challenges. The dramatic shift in demand from services to goods, coupled with the significant supply chain disruptions caused by plant closures, border closings, worker shortages, etcetera, drove prices higher as demand outpaced supply. The war and related events are creating additional upward pressure on inflation and are weighing on global economic activity.
Higher rates of inflation around the globe have required central banks, including our Federal Reserve, to raise interest rates in an effort to cool demand. In its quest to bring down inflation that is running near its highest levels since the early 1980s, the central bank took its federal funds rate up to a range of 3% to 3.25%, the highest it has been since early 2008, following the third consecutive 0.75 percentage point move. The increases, which started in March from near-zero, mark the most aggressive Fed tightening cycle since it started using the overnight funds rate as its principal policy tool in 1990. Projections from its recent meeting indicate that the Fed expects to raise rates by at least 1.25 percentage points in its two remaining meetings this year and peak in the range of 4.5% to 4.75% by the end of next year. The dot plot chart of individual FOMC members’ current projections indicated as many as three rate cuts in 2024 and four more in 2025, to take the longer-run funds rate down to a median outlook of 2.9%.
Markets have been bracing for a more aggressive Fed and the accompanying slowdown in economic growth. Bond yields soared following the Fed’s recent action, with the 2-year and 10-year Treasury rates hitting highs not seen in over a decade. The Bloomberg Aggregate bond index is off 13.8% for the year. Equity markets retested the June lows last week, reentering bear territory with the S&P 500 closing down 21.6%.
According to the legendary investor Warren Buffet, “the true investor welcomes volatility.” Like so many other inspirational quotes, it is easier said than done. It is natural to feel discomfort in times of heightened volatility. We have certainly been here before. Including the current decline, we have experienced nine bear markets, defined as a drop exceeding 20%, in the last 60 years. The duration of the current bear market is yet undetermined, but the last eight lasted an average of 14 months. The shortest was one month (pandemic) and the longest was 30. Arguably, the most similar economic environment was the bear market that began in November of 1980 amid high levels of inflation, commodity price spikes, an aggressive Federal Reserve, and a recession. In that case, the bear market endured for 20 months and declined by 27%. Following this decline, the market entered a sixty-month bull market cycle in which the market gained 229%.
The million-dollar question is where does the pain stop? It is impossible to say, but investors with a long-term perspective should remain optimistic.